Inflation Targeting Topmost Agenda

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Excerpts of the Speech by RBI Governor Shaktikanta Das on the Monetary Policy Committee (MPC) decision to keep interest rates unchanged. Let me begin by setting out the thinking that went into the MPC’s decision and its rationale. The MPC was of the view that inflation is likely to remain elevated, with some relief in the winter months from prices of perishables and bumper kharif arrivals. This constrains monetary policy at the current juncture from using the space available to act in support of growth. At the same time, the signs of recovery are far from being broad-based and are dependent on sustained policy support. A small window is available for proactive supply management strategies to break the inflation spiral being fuelled by supply chain disruptions, excessive margins and indirect taxes. Further efforts are necessary to mitigate supply-side driven inflation pressures. The MPC will monitor closely all threats to price stability to anchor broader macroeconomic and financial stability. Accordingly, the MPC decided today to maintain status quo on the policy rate and continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. The year 2020 has been extremely challenging. It has tested and stretched our capabilities and even our inner reserves of strength, patience and fortitude. As the year draws to a close, it would be appropriate to review our actions and outcomes as we battled against the pandemic. What stood out, in my view, in this all-out endeavour, was our determination to fight and overcome every trial that was flung at us. I am reminded of the words of Mahatma Gandhi and I quote: “Strength …….… comes from an indomitable will1.” Drawing lessons therefrom, I shall try to set out our vision for the way forward. Let me now set out the MPC’s assessment of underlying inflation dynamics and the outlook. CPI inflation rose sharply to 7.3 per cent in September and further to 7.6 per cent in October 2020, with some evidence that price pressures are spreading. The outlook for inflation has turned adverse relative to expectations in the last two months. While cereal prices may continue to soften with the bumper kharif harvest arrivals and vegetable prices may ease with the winter crop, other food prices are likely to persist at elevated levels. Cost-push pressures continue to impinge on core inflation, which could remain sticky. Taking into consideration all these factors, CPI inflation is projected at 6.8 per cent for Q3:2020-21, 5.8 per cent for Q4:2020-21; and 5.2 to 4.6 per cent in H1:2021-22, with risks broadly balanced. Recovery and Beyond Against this backdrop, we must turn our attention to nurturing the recovery beyond the meeting of pent-up demand and focus on setting it on a firm trajectory of sustained, high quality growth. Data that have become available for Q3:2020-21 confirm that the economy is recuperating faster than anticipated and more sectors are joining the multi-speed upturn that I had highlighted in my statement in October. The contraction in Q2 in the NSO’s end-November preliminary estimates has turned out to be shallower than projected in October. The manufacturing and services purchasing managers’ index (PMI) at 56.3 and 53.7 respectively in November 2020 remain in expansion zone. High frequency indicators of services showed stability and increase in the number of upticks (Annex). The recovery in rural demand is expected to strengthen further, while urban demand is gaining momentum as unlocking spurs activity and employment, especially for labour displaced by COVID-19. These positive impulses are, however, clouded by a possible rise in infections in some parts of the country, prompting some local containment measures. At the same time, the recovery rate has crossed 94 per cent and is rising, with considerable optimism on successes in vaccine trials. Consumer confidence over the year ahead has turned optimistic. Corporate results for Q2:2020-21 indicate that demand conditions are recovering and profit margins are rising on the back of cost saving on expenses and debt servicing capacity has gone up. Business assessment of manufacturing firms has entered the expansion zone in Q3:2020-21 after remaining in contraction in the last two quarters. Business expectations going forward into Q4:2020-21 are rising. Turning to the growth outlook, as I stated earlier, the recovery in rural demand is expected to strengthen further, while urban demand is also gaining monentum. Consumers remain optimistic about the outlook and business sentiment of manufactuing firms is gradually improving. Fiscal stimulus is increasingly moving beyond being supportive of consumption and liquidity to supporting growth-generating investment. On the other hand, private investment is still slack and capacity utilisation has not fully recovered. While exports are on an uneven recovery, the prospects have brighteneed with the progress on the vaccines. Taking these factors into consideration, real GDP growth is projected at (-) 7.5 per cent in 2020-21: (+) 0.1 per cent in Q3:2020- 21 and (+) 0.7 per cent in Q4:2020-21; and 21.9 per cent to 6.5 per cent in H1:2021- 22, with risks broadly balanced. Against this backdrop, the RBI will persevere with its paramount objective of reviving the economy with some additional measures in order to (i) enhance liquidity support to targeted sectors having linkages to other sectors; (ii) deepen financial markets; (iii) conserve capital among banks and NBFCs through regulatory initiatives; (iv) strengthen supervision through strengthening the audit functions; (v) facilitate external trade by improving ease of doing business for exporters; and (vi) upgrade payment system services so as to expand financial inclusion and improve customer service. Liquidity Measures to Revive Activity: The on tap targeted long term repo operations announced on 9th October, 2020 will be expanded to cover other stressed sectors in synergy with the credit guarantee available under the Emergency Credit Line Guarantee Scheme (ECLGS 2.0) of the Government. This will encourage banks to extend credit support to stressed sectors at lower cost. Deepening Financial Markets: The Regional Rural Banks (RRBs) are currently not permitted to access the liquidity windows of the Reserve Bank as well as the call/notice money market. With a view to expanding participation in money markets and to facilitate better liquidity management, Regional Rural Banks will be allowed to access the Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF) of the RBI; and also the Call/Notice money market. With the recent enactment of the legislation for Bilateral Netting of fianancial contracts providing a fillip to the underdeveloped credit derivatives market in India, it has been decided to review the extant guidelines on Credit Default Swaps (CDS) and issue draft directions for public comments shortly. The revised directions are expected to facilitate the development of credit derivatives market and a liquid and vibrant market for corporate bonds, especially for lower rated issuers. Conclusion The growth impulses that have emerged augur well for the revitalization of the Indian economy. Policy stimuli by the Government and the RBI are intended to nurture these growth sprouts to greater strength. Efforts are underway to ensure a calibrated unlocking of the economy, with cognisance and caution about the virus. While we remain vigilant, we must now turn to alleviating the scars left by the pandemic and revive the economy. The horizon has lighted up with the spate of positive news on the vaccines, and a steady rise in recoveries. India’s time has come to break free of the fetters of COVID-19 and reconfigure our destiny. We have borne with fortitude and courage the terrible havoc wrought by the pandemic. We have lost lives and loved ones, but not hope, not the conviction that we will overcome and emerge stronger. It is often said that life after COVID will not be the same again, but human endeavour has time and again shown that it is never too late to seek a newer world. We must reach out with a strong will to strive, to seek, to find and not to yield. I am reminded here of a quote attributed to Socrates, “In the face of adversity, we have a choice. We can be bitter, or we can be better”. Obviously we will strive to be better.